Barr v. Wackman, 36 N.Y.2d 371 (1975)
A shareholder derivative suit demand on the board of directors is excused when the complaint alleges particularized facts demonstrating that a majority of the directors may be liable for breach of their duties of due care and diligence to the corporation, even without allegations of fraud or self-dealing.
Summary
A shareholder derivative action was brought against Talcott National Corporation directors, alleging they breached their fiduciary duties. The plaintiff didn’t demand the board initiate action, claiming it would be futile because the board participated in the alleged wrongdoing. The court addressed whether allegations of board participation and approval of acts involving bias by affiliated directors, coupled with the remaining directors’ alleged failure to exercise due care, were sufficient to excuse demand. The court held that the demand was excused because the complaint sufficiently alleged that a majority of the directors might be liable, making it unlikely they would pursue the action.
Facts
Plaintiff, a shareholder of Talcott National Corporation, brought a derivative action against several directors, including affiliated directors (those with official capacities beyond their directorships) and unaffiliated directors (those whose only connection was as directors). The complaint alleged that the affiliated directors, seeking personal benefits, conspired with Gulf & Western Industries to facilitate its acquisition of Talcott on terms less favorable to Talcott’s shareholders. As part of this scheme, the board allegedly abandoned a merger agreement, approved a tender offer, authorized favorable employment contracts for officers, and sold a subsidiary at a loss, all to benefit Gulf & Western and the affiliated directors. The unaffiliated directors allegedly failed to exercise independent judgment and due care.
Procedural History
The defendants moved to dismiss the complaint for failure to make a demand on the board as required by Business Corporation Law § 626(c). The Supreme Court denied the motion, and the Appellate Division affirmed. The case was appealed to the New York Court of Appeals by permission of the Appellate Division on a certified question regarding the propriety of the denial of the motion to dismiss.
Issue(s)
Whether allegations of board participation in and approval of acts involving bias and self-dealing by minority affiliated directors and breach of fiduciary duties of due care and diligence by the remaining majority unaffiliated directors are sufficient to withstand a motion to dismiss for failure to make a demand.
Holding
Yes, because the complaint alleges acts for which a majority of the directors may be liable, and therefore, the plaintiff reasonably concluded that a demand would be futile. The court emphasized that the board’s actions, as part of a series of events benefiting the affiliated directors rather than Talcott, were not immune from question in a derivative action.
Court’s Reasoning
The court reasoned that the demand requirement, codified in Business Corporation Law § 626(c), is rooted in the principle that corporate management is entrusted to the board of directors. The demand rule aims to allow directors to correct alleged abuses without court intervention and to protect them from harassment by litigious shareholders. However, a demand is excused when it would be futile, such as when the alleged wrongdoers control or comprise a majority of the directors. The court emphasized that it is insufficient to merely name a majority of directors as defendants with conclusory allegations. Here, the complaint presented particularized transactions benefiting Gulf & Western and the affiliated directors, while the unaffiliated directors allegedly disregarded Talcott’s interests. The court stated, “Plaintiff may prove that the exercise of reasonable diligence and independent judgment under all the circumstances by the unaffiliated directors, at least to meaningfully check the decisions of the active corporate managers, would have put them on notice of the claimed self-dealing of the affiliated directors and avoided the alleged damage to Talcott. If the unaffiliated directors abdicated their responsibility, they may be liable for their omissions.” The court explicitly rejected the notion that directorial fraud or self-interest is always required to excuse demand, noting that directors have affirmative duties of due care and diligence beyond avoiding self-dealing. The court emphasized, “Particular allegations of formal board participation in and approval of active wrongdoing may, as here, suffice to defeat a motion to dismiss.” The court concluded that the determination of whether a demand is necessary rests in the sound discretion of the court, based on a liberal construction of the complaint. The court cited Kavanaugh v Commonwealth Trust Co., 223 NY 103, 106 stating, “No custom or practice can make a directorship a mere position of honor void of responsibility, or cause a name to become a substitute for care and attention. The personnel of a directorate may give confidence and attract custom; it must also afford protection.”